The Importance of Valuation
Value vs valuation
People get themselves tied up in knots about valuation, which is a distinct concept from value. A business, like anything, has multiple values at any point in time, depending on who is looking and their circumstances.
If the buyer of a business is a mum and dad team looking to escape the workforce, their perception of the value of the business for sale will be different to, say, a competitor, who is interested in the Intellectual Property that has been developed that would save them millions of dollars a year. This competitor has the added sweetener of growing revenue by acquisition and removing a competitive threat.
The former example is in a category we call financial buyers, whose main consideration is ownership at fair value and stability of return and the latter in a category we call strategic buyers, whose main consideration is maximising return.
It is almost always better valuation-wise to position one’s business to appeal to strategic buyers over financial buyers. However, strategic buyers are not simply everywhere, one must work hard to be attractive to them.
Moreover, other alternatives, like managers or employees taking over ownership of the business are still buyers in a sense and would usually occupy the financial category.
A valuation on the other hand, is a report an adviser puts together after analysing a business. There are many reasons to value a business. Apart from the rigour applied (it is usually quite difficult to advise owners on how to grow the value of their business, without first valuing it), they are often used as aids to negotiations for one partner buying out another in a business, for legal restructure purposes or for raising capital.
Your business is an investment
At the end of the day, business buyers are best thought of as investors. They quite legitimately apply plenty of rigour when examining businesses for purchase, because once they commit, they have parted with hundreds of thousands, if not millions of dollars.
Moreover, like any kind of investment both perceived and actual risk play a role in price. Unresolved risks like owner reliance, key person reliance, key customer reliance are all very common value inhibitors.
What many vendors fail to keep in mind is that buyers are rarely under pressure to buy your business. If anything, their menu of investment options is almost infinite: be it in real estate, stocks, bonds, other businesses or any manner of other potential investments. It is, therefore, a difficult undertaking to sell a business, and to be forewarned is to be forearmed.
How periodic valuations help
Periodic valuations are useful guideposts. They can serve to:
- Reverse-engineer what is an acceptable level of business performance given a vendor’s desired sale price;
- Clarify what type of buyer is the right one to orient the business towards (over several years ideally); and
- Be used as a starting point for exploring alternative exit strategies, e.g. establishing an Employee Share Ownership Plan, whereby employees gradually take over ownership over time.